The Coronavirus: top 10 tips for managing legal risks
Dorothee Schramm and David Roney, Partners at Sidley Austin, discuss their top 10 tips for managing legal risk from global supply chain disruption.
As the new coronavirus disease, COVID-19, spreads around the globe, the World Health Organization continues to upgrade its global risk assessment. In addition to the tragic health consequences of COVID-19, the virus is having a major negative effect on international business, disrupting numerous global supply chains.
Countless supply contracts are being disrupted by factory shutdowns in the areas most affected by COVID-19. In recent weeks, Chinese agencies and chambers of commerce have issued thousands of force majeure certificates to Chinese companies. However, COVID-19 will not give rise to a valid force majeure defense under every contract and in every circumstance, as different contracts and governing laws stipulate different requirements for different situations. Companies are therefore well advised to proactively manage the related legal risk and carefully assess which party must ultimately bear the financial losses caused by COVID-19.
The following seven tips will help to manage legal risk when confronted with immediate supply chain problems. Three additional tips will help to create a more robust supply framework for the future. All of these tips will be explained in more detail in an upcoming Sidley Webinar. In the interim, please reach out to your Sidley adviser for assistance with any urgent issues.
Facing Supply Disruptions Caused by COVID-19 – What Now?
COVID-19 may affect your company in different ways. Your own production may be affected by government shutdowns or dwindling numbers of employees coming to work. Alternatively, your suppliers may discontinue shipments, leaving you unable to produce your goods. Whatever the impact of COVID-19, the following tips will help you to manage the situation.
1. Identify the exact nature of the supply problems and document them. Up-to-date knowledge of the facts is crucial for proper management decisions and your ability to prove those facts may determine your success in any subsequent legal proceedings.
If your company is directly affected: Make certain you understand the reasons why you are unable to supply. Is it due to government-ordered factory shutdowns or quarantines, staff illness, staff staying home out of fear or other reasons? Identifying the exact nature of the problem is critically important and you should secure evidence proving the cause of your specific problem.
If your supplier cannot supply you: Do not accept an unspecific force majeure declaration, but ask for details about how exactly your supplier is affected. Do not take a position on the force majeure declaration before knowing the relevant facts.
2. Analyze the risk allocation under your contract and the governing law. Not every contract and governing law provides for a force majeure defense based on unforeseeable events outside the parties’ control. The scope and requirements of force majeure (and similar legal defenses) vary from contract to contract. A careful legal analysis of your specific situation is therefore indispensable and will depend on the exact nature of the supply problems, the specific terms of your contract, and the governing law. If you find yourself facing a force majeure defense by your supplier and, as a result, cannot supply your own customers, you need to assess the risk allocation under each contract separately to develop the best risk management strategy.
3. Say what needs to be said – but beware of the pitfalls. Specific contract terms or the governing law may require you to give prompt notice of a force majeure event, failing which this defense will be barred. If there is such a requirement, you may need to issue a force majeure declaration before you have had the opportunity to complete your assessment of the first two points above. If you receive a force majeure declaration from a supplier, carefully frame your response to protect your legal position and, if you must then issue a force majeure declaration to your own customers, avoid any language that could prejudice your position in a future dispute with your supplier.
4. Make efforts to overcome the supply problems. Many contracts and governing laws exclude a force majeure defense if you can overcome the consequences of the force majeure event. Often, you cannot rely on a force majeure defense to avoid significantly higher costs of supplying alternative goods, unless you are entitled to invoke hardship (which is rare under most governing laws). If you receive a force majeure declaration that you consider invalid, you are obligated to take steps to mitigate your damages. Document all your efforts to overcome the supply problems, particularly if they are unsuccessful.
5. Beware of how you allocate existing supplies. If your reduced production output allows you to supply only some of your customers, allocating the available supplies is tricky. Carefully check your contract and the governing law as to whether they contain any restrictions or guidance. Supplying your priority customers and declaring force majeure vis-à-vis all other customers may be problematic. If you receive a force majeure declaration, find out how your supplier allocates remaining stock.
6. Manage contract disputes proactively to resolve them efficiently. There will be many lawsuits over who must bear the losses caused by COVID-19-related supply chain problems. Managing contract disputes proactively will increase your chances of resolving them efficiently and successfully. Engage with your suppliers and customers in a cooperative and reasonable manner – this will go a long way toward avoiding or resolving disputes. At the same time, take all necessary steps to protect your legal and evidentiary position in the event a dispute escalates, and check your contract’s dispute resolution clause to identify what court or tribunal would decide a dispute and how that adjudicator would likely assess the situation. Sidley can assist with all of these steps through an early case assessment, which will help you decide whether to litigate or seek a settlement, as well as determine an appropriate settlement amount that properly reflects your chances of success in legal proceedings.
7. Putting an end to force majeure. Typically, force majeure serves as a temporary defense, which must be lifted as soon as it can be overcome and supplies can be resumed. Until that time, many contracts require that you provide regular updates. When necessary, you should assess whether your contract and the governing law only excuse temporary non-performance or also entitle you to modify the contract terms or terminate the contract altogether.
Make Your Company Virus-Fit for the Future
After SARS, MERS and the bird flu, it would be optimistic to assume that COVID-19 will be the last global health crisis of this kind. Now is a good opportunity to take measures to minimize global virus-related problems in the future. Here are the top three tips:
1. Have a Plan B (C and D). At present, companies that rely on one supplier in COVID-19-affected areas in China face the biggest challenges. Good supply chain practice mandates several suppliers in different countries and geographies. This practice will minimize the risk of disruptions that are likely to increase in the future, whether they are related to pandemics, climate change, or other global phenomena.
2. Update your force majeure clauses. You should update your template force majeure clause for future contracts or renegotiated contracts to make certain it covers common problems in the event of a global pandemic or similar disruptive phenomena.
3. Pay special attention to your dispute resolution clause. This contract clause will determine whether you can effectively enforce your rights. For example, if you receive an invalid force majeure declaration from a Chinese supplier, a Chinese court may not be the most favorable forum for pursuing a claim for damages. For important contracts where you are the supplier but rely on a sub-supplier, aim to agree in both contracts on compatible dispute resolution clauses that will enable you to resolve virus-related supply disputes under both contracts in a single legal proceeding. Sidley’s experienced international dispute resolution lawyers are well placed to assist you in identifying and negotiating such robust and well-calibrated dispute resolution clauses.
For more information on procurement, supply chain and logistics topics - please take a look at the latest edition of Supply Chain Digital magazine.
NTT DATA Services, Remodelling Supply Chains for Resilience
Joey Dean, the man with the coolest name ever and Managing Director in the healthcare consulting practice for NTT DATA and is focused on delivering workplace transformation and enabling the future workforce for healthcare providers. Dean also leads client innovation programs to enhance service delivery and business outcomes for clients.
The pandemic has shifted priorities and created opportunities to do things differently, and companies are now looking to build more resilient supply chains, none needed more urgently than those within the healthcare system. Dean shares with us how he feels they can get there.
A Multi-Vendor Sourcing Approach
“Healthcare systems cannot afford delays in the supply chain when there are lives at stake. Healthcare procurement teams are looking at multi-vendor sourcing strategies, stockpiling more inventory, and ways to use data and AI to have a predictive view into the future and drive greater efficiency.
“The priority should be to shore up procurement channels and re-evaluate inventory management norms, i.e. stockpiling for assurance. Health systems should take the opportunity to renegotiate with their current vendors and broaden the supplier channel. Through those efforts, work with suppliers that have greater geographic diversity and transparency around manufacturing data, process, and continuity plans,” says Dean.
But here ensues the never-ending battle of domestic vs global supply chains. As I see it, domestic sourcing limits the high-risk exposure related to offshore sourcing— Canada’s issue with importing the vaccine is a good example of that. So, of course, I had to ask, for lifesaving products, is building domestic capabilities an option that is being considered?
“Domestic supply chains are sparse or have a high dependence on overseas centres for parts and raw materials. There are measures being discussed from a legislative perspective to drive more domestic sourcing, and there will need to be a concerted effort by Western countries through a mix of investments and financial incentives,” Dean explains.
Wielding Big Tech for Better Outcomes
So, that’s a long way off. In the meantime, leveraging technology is another way to mitigate the risks that lie within global supply chains while decreasing costs and improving quality. Dean expands on the potential of blockchain and AI in the industry.
“Blockchain is particularly interesting in creating more transparency and visibility across all supply chain activities. Organisations can create a decentralised record of all transactions to track assets from production to delivery or use by end-user. This increased supply chain transparency provides more visibility to both buyers and suppliers to resolve disputes and build more trusting relationships. Another benefit is that the validation of data is more efficient to prioritise time on the delivery of goods and services to reduce cost and improve quality.
“Artificial Intelligence and Machine Learning (AI/ML) is another area where there’s incredible value in processing massive amounts of data to aggregate and normalise the data to produce proactive recommendations on actions to improve the speed and cost-efficiency of the supply chain.”
Evolving Procurement Models
From asking more of suppliers to beefing up stocks, Dean believes procurement models should be remodelled to favour resilience, mitigate risk and ensure the needs of the customer are kept in view.
“The bottom line is that healthcare systems are expecting more from their suppliers. While transactional approaches focused solely on price and transactions have been the norm, collaborative relationships, where the buyer and supplier establish mutual objectives and outcomes, drives a trusting and transparent relationship. Healthcare systems are also looking to multi-vendor strategies to mitigate risk, so it is imperative for suppliers to stand out and embrace evolving procurement models.
“Healthcare systems are looking at partners that can establish domestic centres for supplies to mitigate the risks of having ‘all of their eggs’ in overseas locations. Suppliers should look to perform a strategic evaluation review that includes a distribution network analysis and distribution footprint review to understand cost, service, flexibility, and risks. Included in that strategy should be a “voice of the customer” assessment to understand current pain points and needs of customers.”
“Healthcare supply chain leaders are re-evaluating the Just In Time (JIT) model with supplies delivered on a regular basis. The approach does not require an investment in infrastructure but leaves organisations open to risk of disruption. Having domestic centres and warehousing from suppliers gives healthcare systems the ability to have inventory on hand without having to invest in their own infrastructure. Also, in the spirit of transparency, having predictive views into inventory levels can help enable better decision making from both sides.”
But, again, I had to ask, what about the risks and associated costs that come with higher inventory levels, such as expired product if there isn’t fast enough turnover, tying up cash flow, warehousing and inventory management costs?
“In the current supply chain environment, it is advisable for buyers to carry an in-house inventory on a just-in-time basis, while suppliers take a just-in-case approach, preserving capacity for surges, retaining safety stock, and building rapid replenishment channels for restock. But the risk of expired product is very real. This could be curbed with better data intelligence and improved technology that could forecast surges and predictively automate future supply needs. In this way, ordering would be more data-driven and rationalised to align with anticipated surges. Further adoption of data and intelligence and will be crucial for modernised buying in the new normal.
These are tough tasks, so I asked Dean to speak to some of the challenges. Luckily, he’s a patient guy with a lot to say.
On managing stakeholders and ensuring alignment on priorities and objectives, Dean says, “In order for managing stakeholders to stay aligned on priorities, they’ll need more transparency and collaborative win-win business relationships in which both healthcare systems and medical device manufacturers are equally committed to each other’s success. On the healthcare side, they need to understand where parts and products are manufactured to perform more predictive data and analytics for forecasting and planning efforts. And the manufacturers should offer more data transparency which will result in better planning and forecasting to navigate the ebbs and flows and enable better decision-making by healthcare systems.
Due to the sensitive nature of the information being requested, the effort to increase visibility is typically met with a lot of reluctance and push back. Dean essentially puts the onus back on suppliers to get with the times. “Traditionally, the relationships between buyers and suppliers are transactional, based only on the transaction between the two parties: what is the supplier providing, at what cost, and for what length of time. The relationship begins and ends there. The tide is shifting, and buyers expect more from their suppliers, especially given what the pandemic exposed around the fragility of the supply chain. The suppliers that get ahead of this will not only reap the benefits of improved relationships, but they will be able to take action on insights derived from greater visibility to manage risks more effectively.”
He offers a final tip. “A first step in enabling a supply chain data exchange is to make sure partners and buyers are aware of the conditions throughout the supply chain based on real-time data to enable predictive views into delays and disruptions. With well understand data sets, both parties can respond more effectively and work together when disruptions occur.”
As for where supply chain is heading, Dean says, “Moving forward, we’ll continue to see a shift toward Robotic Process Automation (RPA), Artificial Intelligence (AI), and advanced analytics to optimise the supply chain. The pandemic, as it has done in many other industries, will accelerate the move to digital, with the benefits of improving efficiency, visibility, and error rate. AI can consume enormous amounts of data to drive real-time pattern detection and mitigate risk from global disruptive events.”